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19.In light of the above, there are two ways of weighing the benefits against the potential costs of MR. We can ask whether and when mutual recognition is desirable in contrast with its alternatives. We can also ask to what extent mutual recognition, if adopted, needs to be "managed" to take account of its costs and offer safeguards for signatories. Even if for trade purposes the case in favour of mutual recognition can be made forcefully, positions need to be more nuanced when we turn to regulatory and political implications of MR.
20.The trade facilitation benefits of MR are obvious and have often been repeated. By only having to comply with one national standard or regulation, exporters avoid adaptation costs and may reap previously unrealized economies of scale; by doing away with repetitive testing and certification in importing countries, exporters avoid not only the associated expenses, but also delays that can be especially costly to short life-cycle products. Moreover, MR provides certainty to the producer in a context where host country conformity assessment leaves the door open to arbitrary decisions due to outright protectionism. The exporter also avoids the risk of an importing country carrying out reverse engineering, infringing on intellectual property rights or engaging in unauthorised technology transfer through the process of evaluating the performance of imports.[11]
21.Obviously, these potential benefits vary with the actual compliance costs, themselves a function of differences in applicable regulations and extent of potential economies of scale. It is important to take such variation into account since a judgement on the judicial enforceability or the political desirability of MR involves weighing regulatory costs against trade benefits. To take the case of professional services, adapting to local training and certification requirements may require a significant proportion of one's life (the need for mutual recognition of diploma was the only instance of MR foreseen by the Treaty of Rome) whereas local conduct rules are not so costly to comply with. Permanent establishment may justify a greater adaptation effort than sporadic cross border provision of services. For banks, compliance costs linked to structural adaptation such as specialisation requirements (commercial Vs investment banking) are likely to be so high as to prohibit trade altogether (there MR was introduced in the EU by the second banking directive adopted in 1989 but does not exist between the US and the EU).
22.There also exist differentiated market incentives to seek mutual recognition. Consumers may want to import a product banned in the host country (pharmaceuticals, food products, types of financial products, professional practices, temporary employment agencies). In this case, mutual recognition is synonymous with market access. Conversely, market incentives may require that adaptation costs be incurred anyway, where local regulations have strongly shaped the local demand for specific product-types; or where adaptation is an integral part of the product offered (providing advice on local law). Even in the latter cases, voluntary adaptation may be less cumbersome and as effective as having to provide the proofs of such adaptation.
23.Specifically in the realm of services, lack of MR can simply preclude certain types of international transactions entirely, at least through the means of cross-border trade as opposed to permanent local establishment since local control requires local presence. It has become a clichÈ to point out that through communication networks a firm engaged in long-distance data processing services or provision of financial information, or a bank offering portfolio management services, can operate entirely from their home base. Mutual recognition is a prerequisite to network-based service delivery which amounts to a right of non-establishment. Even for services which need to be customised through interaction with the customer (e.g. investigative capacity of insurance), local presence could be reduced to simple offices, which is impossible without mutual recognition of supervisory functions.
24.It is clearly difficult to assess the extent to which regulatory requirements as opposed to technological and demand requirements influence actors' export and location strategies. Mutual recognition may translate into a small market share in the short run yet may have a significant influence on the competitive environment of the importing country.
25.Three broad categories of regulatory rationale can be invoked in favour of MR. First, MR introduces freedom of choice for the consumer, extending the traditional argument in favour of free trade to the freedom to chose among rules. Some consumers will derive greater benefit from stringent regulations even at higher cost while others will favour lower price/lesser quality packages. Second, regulatory competition introduced by mutual recognition is likely to increase the efficiency of regulations by acting as a "means of discovery" and even lead to convergence towards some "optimal" through the arbitrage of consumers and firms rather than bureaucracies.[12] Third, mutual recognition can improve regulatory practices directly through better division of labour and enhanced co-operation between regulators or private regulatory bodies. Regulators can reallocate the resources previously devoted to redundant control of foreigners and increase their capacity to operate domestically and to collaborate with their counterparts. The negotiation of MRAs externally can even constitute the impetus for streamlining domestic regulatory systems, including to address problems of redundancy in federal systems (for instance in the United States). These arguments are all-the-more powerful that they suggest a synergy rather than tension between trade and regulatory objectives.
26.Nevertheless, it would be difficult to deny that pure mutual recognition does have regulatory costs. At a minimum, the primary rationale for domestic regulation -e.g. to correct market failures which include externalities, market power, and asymmetric information- is put into question.[13] First, because states hold very different notions of what market failures are and how they should be corrected. Second, market failures may actually be magnified under MR: information asymmetries may be greater between consumers and suppliers from different countries. Third, home state regulatory or conformity assessment bodies alone may not have the capacity to effectively enforce their counterpart's regulation or their own across jurisdiction. Fourth, mutual recognition risks introducing a new basis for "unfair competition." Fifth, mutual recognition may create incentives for deregulatory competition and a race-to-the-bottom between regulators.
27.Such arguments do not all have the same force. The extent to which they justify limiting the adoption of MR has been extensively debated, in particular in European circles. The temporary outcome of these debates and deals between regulators or bodies with delegated authority have formed the basis for the "managed" character of mutual recognition in the EU context, including various degrees of prior harmonization, reduction in regulatory scope and progressive expansion of such scope, safeguard clauses for the host state and provisions for mutual oversight between regulatory bodies. A few general points illustrate these considerations. In order of importance:
28.The existence of negative externalities usually justifies levels of prior harmonization close to those of countries with the most stringent regulation, although with disagreement over how to define stringency. This includes cases where safeguarding systemic integrity across jurisdiction is concerned (capital adequacy or "no harm to network" requirements) or where externalities are confined to the specific territory where a good is consumed (auto emission) or a service provided (security norms in road transport).
29.The extent to which consumer protection considerations justify managed MR depends less on whether regulatory objectives among signatories are shared (they always seem to be) than on whether:
a)Regulators can justify changing the risk tolerance reflected in their practice. Some of the greatest tensions in implementing MR arise from differences in risk threshold demanded by the public (in pharmaceuticals tolerance of type I errors -harmful drugs- Vs type II errors-forgoing the benefits of a new drug) or level of confidence in respective methods to verify compliance (types of test conducted for auto safety). An extended preliminary phase of confidence building is key in these instances.
b)Reputation effects exist and can be magnified through information requirements. For those who believe that caveat emptor ought to be the core organising principle of capitalist societies, reputation is how markets deal with information asymmetries between consumers and suppliers: under MR different regulatory systems will find different market niches with different groups of consumers across countries. They may concede that the information provided by the market left to itself may be sub-optimal. Adoption of MR may require that regulatory reallocation be made explicit in the eyes of consumers through labelling requirement (such as "this product has been tested abroad") or signalling requirements (such as the use of the appropriate professional title or the requirement that the consumer sign a declaration acknowledging foreign jurisdiction as with the EU second insurance directive). It may require more when reputation effects are not applicable (costs of learning about foreign "labels"; small probability of a very high cost -e.g. insurance bankruptcy, unqualified physician; unawareness that technical product features may vary with applicable regulation -- e.g. coverage of insurance contracts). An especially great need for prior convergence arises when one party tends to rely on liability rules rather than direct government intervention (arguably plagued by the same information asymmetry problem as consumers) and may thus extend less protection to foreign consumers.
c)Whether it is possible to exclude from MRAs certain classes of consumers (insufficiently informed, trained to use a product or supported by a "use" system) or certain sub-sectors or products where the protection afforded likely depends on consumer characteristics (in insurance; machine tools; food). The safety of powdered milk depends on the quality of water locally available. Where health and safety is concerned, consumers need to be able to include underlying regulations in their investigation.
30.The third rationale for limiting MR, namely that regulatory differentials introduce competitive distortions or unfair competition is grounded in the belief that a more "level" playing field needs to be part of deeper integration, just as social contracts were part of nation-building. The adoption of MR in spite of remaining differences in both input and output regulations can lead to reverse discrimination of nationals (Inl°/oonderdiskrimminierung ) -banned from practices or markets opened to their competitors from other member states or facing higher costs through more stringent quality, security, soundness or social standards. The argument is greatly mitigated by countervailing factors. In addition to the aforementioned reputation effects, "costly" regulations are often correlated with counterbalancing comparative advantages, such as human capital, productivity, or reliable infrastructures so that the competitive impact of MR is a wash. One of the "hard cases" is whether MR should extend to the social conditions of workers employed under low social protection by foreign firms (e.g. construction) operating temporarily in the importing country. It is hard to make the case that local firms do not have countervailing sources of comparative advantage although there may be an externality case for host country jurisdiction (disruption of local social contract).
31.Finally, although the question is extensively debated there is little concrete evidence for the argument that regulatory competition may lead to a race to the bottom (as opposed to more efficient regulations). The diagnosis rests on two assumptions which often do not hold. First that regulatory bodies do find themselves in a so-called prisoner's dilemma, whereby if their counterparts defect (relax or scrap their regulations) they will have an incentive to follow suit. In fact, they may value their regulatory objectives more than the marginal loss of competitiveness or such losses may be deemed unlikely (reputation effects and mitigating factors mentioned above). Second, that even if such incentives do operate, regulators will act on them and relax their regulation. Regulators usually assume that they are in a "repeated game" and that their behaviour is observable so that gains from following suit would be short lived. In practice, managed mutual recognition serves to limit the potential for deregulatory competition. Adequate safeguard clauses in particular can play a key role. I will come back to this point in section V of this paper.
32.Beyond the debates over matters of degree (acceptable impediment to trade, level of necessary consumer protection, desirability of deregulation) the ultimate argument in favour of mutual recognition is political. This is a way to ensure subsidiarity at the world level in an era when citizens feel increasingly alienated by the economic forces of globalisation and homogenisation. Subsidiarity -the European term for the obligation to act at the lowest level possible- is synonymous here with the protection of state sovereignty and the diversity of local and national traditions. During the ratification campaign for the Maastricht Treaty, Jacques Delors never tired to point out how Brussels had practice subsidiarity avant la lettre by promoting mutual recognition as a means to complete the single market. While the argument is obviously valid, it is important to stress its limits.
33.Indeed, if mutual recognition falls short of a supranational transfer of power it constitutes a transnational transfer of power that may with time come to be seen as much of an infringement on sovereignty. For one, governments forego their traditional monopoly of territorial control through the creation of islands of extraterritorial laws on their soil, on which their own citizens may unknowingly loose the protection of the state. Second, while MR is supposed to at least leave state powers intact with regards to its own national products and actors, its implementation may end up constraining states in their regulatory practices in more radical ways than participation in supranational processes (obviously a potentially beneficial effect as discussed above, but certainly a constraint on sovereignty).
34.Furthermore, horizontal rather than vertical transfer affords less control over the delegated authority : states are usually part of, indeed often sole constituents of, supranational decision making process but do not participate formally in each other's regulatory fora. In turn, mutual recognition puts into question democratic models of representation since it will not necessarily be perceived as a instance of "nearness" (the popular term for subsidiarity) by the citizens. For national lobbies, NGOs and consumer groups, supranational regulatory fora are likely to be more accessible and transparent than those of other states. If a citizen is harmed by a drug or a machine approved by a foreign regulatory authority recognised as competent by his state, who is ultimately accountable? To be sure, and by the same token mutual recognition may strengthen the state apparatus by providing ammunition against regulatory capture. But political accountability may be better guaranteed by overlapping jurisdiction through harmonization than by extraterritorial jurisdiction. Hence the paradox that mutual recognition can be both introduced and contested in the name of subsidiarity.
35.Finally, in terms of corresponding political vision, mutual recognition is vulnerable to criticism by both advocates of diversity and unity. Diversity of choice under MR may hinder diversity tout court by submitting "diversity of polity' to market forces and thus for instance, threatening local traditions as long-standing but fragile social constructs, which need to be protected from what may be termed "cultural dumping." European citizens may have applauded the abandonment of the "Euro-breads" plans of the 1970s, but under MR, Italians no more have a say in how to define "pasta", Germans "beer" and the French "dairy products." At the other end of the spectrum, some will argue that an increasingly integrated economic space (Europe today, the world tomorrow) should aim towards common rules irrespective of the market-based rationale for doing so. The flanking policies accompanying the Europe 1992 program -be it in the field of environment, social policies, or for that matter in the design of common consumer protection guidelines- were not only geared at smoothing the functioning of the single market but maybe more importantly at raising the general standards of living for citizens across Europe. But while such policies were certainly considered by many as crucial elements of the European project, they were pursued in parallel with, rather than as prerequisite to, the implementation of mutual recognition. The balance to be struck between unity and diversity among polity needs to be the object of an explicit political debate and not only emerge as a by product of technical bargains over mutual recognition.
[11] Clarke (1996) emphasizes this point especially with regards to newly industrialized East Asia countries.
[12] An extreme -but not necessarily dominant- version of this argument is that mutual recognition serves as a means of diffusing deregulation across national lines.
[13]Although economists have argued extensively over what should qualify as market failures, whether regulatory methods are properly targeted on the market failure they seek to address, what is the appropriate tradeoff between the benefits of regulation and the benefits of competition, and whether the regulatory or government failures inherent in regulatory intervention do not ultimately render such intervention inefficient, irrespective of the worthiness of its primary goal.
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